May 12, 2016
By David Spence

The American satirist, H. L. Mencken, once said “injustice is relatively easy to bear, what stings is justice.”  Perhaps no case more aptly illustrates Mencken’s view than a 2009 United States Tax Court case called Charnia Estate v. Commissioner, 133 T.C. 7 (September 14, 2009).  The story involves true injustice from an evil dictator, and ultimately painful, blind “justice” as meted out by the United States Internal Revenue Service.

The Charnia case can be very instructive to those of us who give tax or financial advice to non-resident alien (NRA) clients or clients who have NRA family members.  Please, bear with a few background details about the case.  You’ll find it entertaining.  Guaranteed, or your money back.

Some Background

Mr. and Mrs. Charnia were born and raised in Uganda in the 1930s of Asian parents.  Uganda was at the time a British protectorate, so its people were considered U.K. citizens.  In 1962, Uganda became independent of Britain, but Mr. and Mrs. Charnia remained UK citizens, living in independent Uganda.  Mr. and Mrs. Charnia were married in Uganda in 1967.  In 1972, Idi Amin, then President of Uganda, in a horrendous act of “ethnic cleansing,” ordered the expulsion of all Ugandans of Asian descent—giving them 3 months to leave the country.  Mr. and Mrs. Charnia left Uganda forever in October 1972, leaving all their property in Uganda.

A horrific, painful injustice was done.

Eventually, the Charnia family chose to make Belgium their home because of Mr. Charnia’s prior business dealings there.  Mr. and Mrs. Charnia lived and prospered in Belgium for many years until Mr. Charnia’s death in 2002.  Nevertheless, Mr. and Mrs. Charnia remained UK citizens their entire lives.

The Charnia family had become very prosperous in their business, and when Mr. Charnia died on January 31, 2002, he owned 250,000 shares of Citigroup common stock.  At $47.16 per share, Mr. Charnia’s estate held $11,790,000 worth of common stock of Citigroup (a U.S. corporation).  Six months later, unfortunately, the Citigroup stock was only worth $33.25 per share, or $8,312,500.

Mrs. Charnia must have been a compulsive law abider; because, despite no known public evidence of ever having set foot in the United States of America, Mr. Charnia’s estate filed a U.S. Estate Tax Return (as it properly should have), reporting its ownership of the Citigroup stock.  Because Belgium recognizes community property law, the estate excluded Mrs. Charnia’s one-half, community property interest (125,000 shares) from the taxable estate.

The IRS challenged the community property claim by the estate, arguing that, since the couple was married under UK law, and the UK does not recognize community property, the entire 250,000 shares (including the half which the estate claimed were owned by Mrs. Charnia as her share of community property) should be subject to US estate tax.  The IRS demanded in excess of $2,000,000 in estate taxes and penalties from the estate.  The estate disagreed, and petitioned the U.S. Tax Court.

Why Care about This Sad, Strange Story?

The legal issue this court case decided actually involved an analysis of the arcane conflict-of-laws rules between Belgium and the UK marital property.  And in the end, the IRS won the case—the Tax Court held that UK property law governed this couple’s rights to their marital property and so all the Citigroup stock was taxable in Mr. Charnia’s estate.  But that’s not really what matters to those of us not living in Belgium.

This case teaches us (or reminds us of) some important pieces of advice for our clients who fit any of the following three characteristics: a) they are NRAs, b) they have NRA family members, or c) they have large, undiversified holdings.

Specifically, here are some things we should learn:

  1. Nonresident Non-citizens of the U.S. are Subject to Estate Tax on their Stock in U.S. Corporations. This is not new law, but this case is a reminder that in this “information age” we cannot expect to do tax planning based on “playing the tax audit lottery.” It is generally a bad idea for wealthy foreign persons to die in possession of stock in U.S. corporations.
    1. The Charnia family might have avoided some or even all of the U.S. estate taxes by taking some very simple planning steps, like:
      1. Executing a written agreement prior to his death, transmuting Mr. Charnia’s Citigroup stock to community property with his wife, such that, under local (Belgian) law, the surviving spouse, Mrs. Charnia, is the owner of one-half of the shares (this might have avoided including Mrs. Charnia’s community property half of the shares in Mr. Charnia’s taxable estate);
      2. giving the Citigroup stock away during Mr. Charnia’s lifetime (this works because the U.S. generally does not subject NRAs to gift taxes for gifts of stock—even U.S. corporation stock);
  • holding the U.S. corporation stock in a separate entity, incorporated under the laws of a country other than the U.S. (this may have avoided including any of the stock in Mr. Charnia’s taxable estate—thereby saving nearly $4MM in U.S. estate taxes).
  1. Devising the stock at death to a Qualified Domestic Trust (QDOT), with a U.S. bank as trustee (this would have at least deferred the tax until the surviving spouse’s, Mrs. Charnia’s, death).
  1. Selling the stock during Mr. Charnia’s lifetime, and putting the proceeds of the sale in a personal, non-business, U.S. bank account would also have avoided estate taxes, because personal, depository bank accounts are generally exempt estate taxes otherwise imposed upon the taxable estates of deceased NRAs.
  1. Diversification is a Very Important Component to Wealth Management Success. On the date of Mr. Charnia’s death, his Citigroup stock was valued at $47.16 per share.  Six months later, on the estate tax alternate valuation date, the value was $33.25 per share.  But, on the date the U.S. Tax Court handed down its decision that the estate tax was owed, the value of Citigroup shares was about $4.50 per share.  Hopefully the Charnia estate would have already sold and diversified its Citigroup holdings by that time.  But if the same shares had not been sold, the taxes and penalties due to the IRS on the estate’s Citigroup shares would have been about four times the value of the underlying shares!
  2. The United States government is getting very aggressive (and being very successful) in pursuing opportunities for tax revenues—particularly those related to assets “located” (or deemed to be located) outside the U.S.

Fiscal issues with the U.S. government, combined with the current political environment, have made tax compliance for offshore assets even more important to the IRS.  Now that the government is armed with even more detailed information than was available at the time of the Charnia case, the IRS’ reach is now in fact very, very long.

July 26, 2012
By David Spence

Last month’s Royse Law Firm Newsletter article discussed the potential benefits of using Grantor Retained Annuity Trusts (“GRATs”) to transfer wealth in an economic climate of low interest rates and potentially undervalued assets. This article discusses a similar estate planning technique that also works well in the current economic climate—the Charitable Lead Annuity Trust (“CLAT”). A CLAT is designed to transfer wealth to beneficiaries while minimizing gift tax consequences; however, unlike the GRAT, the CLAT also has a charitable purpose. A CLAT is particularly applicable to clients who are regular contributors to charity. This technique allows a person who regularly gives to charity to use his or her gifts as a mechanism for saving not just income taxes, but also estate and gift taxes.

Creation of a CLAT
A CLAT is created when a person (the grantor) transfers one or more potentially high-yield assets into an irrevocable trust. A charity is granted the right to an annuity interest for a fixed term of years. At the end of the fixed term, the assets remaining in the trust are distributed to the named beneficiaries, usually children or grandchildren of the grantor.


Taxable Gift
The funding of a CLAT creates a taxable gift; however, the amount of the taxable gift is determined by subtracting the present value of the charity’s annuity interest from the fair market value of the assets transferred to the CLAT. The present value of the annuity interest is determined by discounting the value of the annuity using the rate prescribed by Internal Revenue Code Section 7520 (the “7520 rate”). This 7520 rate becomes a “hurdle rate,” such that any increase in the value of the assets in excess of this hurdle rate is shifted to the beneficiary without gift tax consequences to the grantor.

Income Tax Effects
A CLAT also has beneficial income tax consequences. The CLAT can be structured to allow the grantor to take a charitable contribution deduction for income tax purposes either (a) in the amount of the present value of the annuity payments that will be paid to the charity (this makes a CLAT an especially useful tool in years with high taxable income), or (b) as an annual deduction, offsetting the annual income earned on the trust assets. Now is a great time to create a CLAT, because the historically low 7520 rate will help maximize the large lump-sum deduction available on the grant of the annuity.

For income tax purposes, the CLAT is treated as a grantor trust; and therefore, the grantor is taxed on all the income and gains from trust assets. This feature further enhances the CLAT’s effectiveness because the grantor is effectively paying the income tax on behalf of the beneficiaries.

The benefits of a CLAT are best illustrated through an example. Consider the following scenario. An individual owns real property, valued at $1,000,000, which is expected to generate income of 8% per annum (rental income plus appreciation). The property owner wants to use a CLAT to contribute $250,000 to charity and give the remainder to his children after a ten-year period. The income stream of the CLAT would look like this, based on a July 2012 transfer with a Section 7520 rate of 1.20%:

Opening Principal
8% Growth

This arrangement produces significant income tax and gift tax benefits. For income tax purposes, there could be either a lump-sum charitable contribution deduction of the present value of the annuity payments, which in this case is $234,263, or an annual income tax deduction of $25,000. For gift tax purposes, the taxable gift is calculated as the fair market value of the assets ($1,000,000) less the present value of the annuity payments ($234,263). Therefore in this scenario, the grantor has transferred $1,796,761 to the beneficiaries, with only $765,737 ($1 Million – $234,263) treated as a taxable gift. In addition, the grantor can pay the income tax due on the income, so the beneficiaries are effectively receiving the income tax free.

If you would like to discuss a CLAT or any other estate or gift tax planning strategies that may be right for you, please contact David Spence, who leads Royse Law Firm’s Trust, Estate & Wealth Strategies Practice at 650-813-9700 ext. 211, or by email at


June 20, 2012
By David Spence and Chris Davis

A grantor retained annuity trust (“GRAT”) can be an effective means for an individual to transfer property to a desired beneficiary with minimal gift or estate tax consequences. A GRAT may be particularly useful for individuals who have assets that are likely to achieve a return at above market interest rates.

Creation of a GRAT
A GRAT is created when a person (the grantor) transfers one or more potentially high-yield assets into an irrevocable trust, retaining the right to an annuity interest, generally for a fixed term of years. When the term of years ends, the assets remaining in the trust are distributed to the named beneficiary.

Taxable Gift
The IRS values the reportable taxable gift by subtracting the present value of the retained annuity from the fair market value of the asset that went into the GRAT. The result of the IRS method of valuation is that the appreciation in the GRAT in excess of the interest rate used in calculating the present value of the retained annuity is effectively shifted to the beneficiary without gift tax consequences to the grantor. When interest rates are low, as they are now (historically low), this GRAT technique works extremely well.

Income Tax Effects
The GRAT is treated as a grantor trust for income tax purposes. This means that the grantor is treated as the owner of the assets, together with all of their income and other income tax attributes. The grantor, therefore, is taxed on income and realized gains on trust assets even if these amounts are not required to be distributed to the grantor. This feature further enhances the GRAT’s effectiveness as a family wealth-shifting and estate-tax-saving device. In essence the grantor is allowed to pay the taxes on income accruing to the benefit of the beneficiary.

If you would like to discuss a GRAT or other estate or gift tax planning strategies that may be right for you, please contact David Spence, who leads Royse Law Firm’s Trust, Estate & Wealth Strategies Practice at 650-813-9700 ext. 211, or by email at

December 27, 2010
By David Spence

You have probably been reading in the newspapers, and hearing on radio and television news aboutThe Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (i.e. “2010 Tax Relief Act,” or “The Act” for purposes of this memo), which was signed into law by the President on Dec. 17, 2010. There are lots of new tax provisions in The Act.  I am writing this memo to our clients to highlight some of the estate tax, gift tax, and generation-skipping transfer (“GST”) tax provisions of this new legislation relevant to common estate plans and planning structures.

Under the so-called “Bush Tax cuts” of 2001, the estate tax was “phased out” such that there was no estate tax for decedents dying in 2010. But, these cuts always had a 10-year lifespan, and were set to expire on December 31, 2010.  The expiration of the Bush tax cuts would have resulted in substantial tax increases on January 1, 2011—back to pre-2001 levels.

The 2010 Tax Relief Act significantly reduced these looming tax increases (though The Act still represents an increase in the estate tax from 2010 levels). Nevertheless, don’t be mislead by news reports—the 2010 Tax Relief Act provides only temporary relief. The relief is only for wealth transfers in 2011 and 2012. Much harsher rules are slated to return, beginning in 2013—unless Congress again takes action.

The 2010 Tax Relief Act “lowers” estate, gift, and GST taxes for 2011 and 2012 by increasing the exemption amount from $1 million to $5 million and by reducing the top tax rate from 55% to 35%. The $5 million exemption is per estate or per lifetime donor—not per recipient. But, due to the new portability provision described below, up to $10 million in total estate tax exemption is now available for a married couple.

The Act also brings back the estate tax retroactively for 2010 (in a semi-optional way), by allowing estates of decedents dying in 2010 to choose between being subject to (A) the new, 2011 law—estate tax based on a $5 million exemption and 35% tax rate, with a fair market value basis, or (B) the former, 2010 law—no estate tax and modified carryover basis in inherited assets. The executor, therefore, can choose whichever version of the law which would produce the lowest combined estate and income taxes for the estate and its beneficiaries.

The Act re-integrates the estate tax, gift tax and GST tax exemptions at $5 million. From a gift tax perspective, this reunification is a tremendous (although temporary) boon.  Many of our clients have already used most if not all of their $1MM gift tax exemptions previously available. Now, (and for the next two years under the Act), there will exist an opportunity to leverage up to an additional $4 million of gift tax and GST tax exemption for each taxpayer. Using proper, tax-efficient wealth-transfer strategies, this additional amount of exemption will enable many of our clients to eliminate estate, gift, and GST tax costs completely from their estates. But, like the other key parts of the Act, this exemption increase, and tax rate decrease is scheduled to expire on December 31, 2012.

Perhaps the most interesting structural change in the law made by The Act is the new “portability” feature available to married couples. Under this provision, the amount of any estate tax exemption that remains unused after the death of a spouse is generally available for use by the surviving spouse’s estate, as an addition to the surviving spouse’s exemption available. A surviving spouse, therefore, may use the predeceased spousal carryover in addition to his or her own $5 million exclusion for taxable transfers made during life or at death.

This exemption “carryover” is available to a surviving spouse only if an election is made on a timely filed estate tax return for the predeceased spouse’s estate—regardless of whether the estate of the predeceased spouse otherwise would be required to file an estate tax return. So, this “carryover” opportunity increases the likelihood that one’s estate will have to file an estate tax return. Beware, however, that only the last spouse’s exclusion “carryover” is available to the spouse.  So, one cannot re-marry in a serial fashion to accumulate exemption. There also, now exists a tax disincentive to get remarried to someone who has less exemption “carryover” available than one’s previous spouse had provided.

Illustration One: Husband 1 dies in 2011 with a $3 million estate. An election is made on his estate tax return to permit Wife to use his $2 million remaining unused exclusion. As of Husband 1’s death, Wife has made no taxable gifts. Thereafter, Wife’s applicable exclusion amount available is $7 million (her $5 million basic exclusion amount plus $2 million “carryover” unused exclusion amount from Husband 1), which she may use for lifetime gifts or for transfers at death.

Illustration Two: Assume the same facts as in the prior illustration, except that Wife subsequently marries Husband 2. He also predeceases Wife, having made $4 million in taxable transfers and having no taxable estate. An election is made on his estate tax return to permit Wife to use his unused exclusion amount. Although the combined amount of unused exclusion of Husband 1 and Husband 2 is $3 million ($2 million for Husband 1 and $1 million for Husband 2), only Husband 2’s $1 million unused exclusion is available for use by Wife. Thereafter, Wife’s estate & gift tax exclusion amount is $6 million (her $5 million basic exclusion plus the $1 million unused exclusion amount from Husband 2), which she may use for lifetime gifts or for transfers at death.

Bypass Trusts Still Viable. Prior to the existence of this portability, or “carryover” feature, the most common way to make sure the full exemption available to a married couple would be utilized was to cause a Bypass Trust to be created on the death of the first spouse. One might think, therefore, that this new portability feature could make a Bypass Trust obsolete. But, the portability feature merely helps the unprepared. There remain many reasons (both tax and non-tax related) for creating a Bypass Trust, including the following:

  1. A Bypass Trust removes from the surviving spouse’s taxable estate not only the current value of the Bypass Trust assets, but also any appreciation on those assets.
  2. The GST tax exemption is not portable; so, if there is a chance that grandchildren or similar beneficiaries will inherit any part of the estate, the Bypass Trust is likely the best vehicle for preserving the GST tax exemption.
  3. The Bypass Trust removes the tax disincentive to remarrying.
  4. The Bypass Trust protects the dispositive desires of the first spouse to die.
  5. The Bypass Trust can provide added creditor protections when compared to outright ownership by the survivor (and in some cases when compared to a Marital or QTIP trust).
  6. Perhaps most importantly, the portability provision, like most of the Act, is temporary—it is set to expire 12/31/2012.

“Optional” Bypass Trust Structure. For many of our Royse Law Firm estate planning clients, an “Optional Bypass Trust” has been built into the revocable trust structure, using a “qualified disclaimer” by the surviving spouse. This disclaimer provision allows the surviving spouse to use his or her power to cause the creation of a Bypass Trust by conscious choice after the death of the first spouse by executing the disclaimer within nine months after the death of the first spouse. For those of our clients for whom the Bypass Trust provisions in your revocable trust instrument are not “optional,” you should revisit whether or not you would like to make the Bypass Trust optional.

The period beginning January 1, 2011 presents tremendous opportunities for estate, gift and GST tax planning. These opportunities are temporary, as this temporary tax law will likely change again prior to January 1, 2013—very possibly not for the better. Tax rates could go up (from 35% to 55%), exemptions could go down (from $5 million to $1 million), and certain other benefits could expire. In addition, although we are only lawyers, not economists, most of the economists we are hearing from today believe our current economic climate of low interest rates and low tax rates is also likely to be short lived. We are experiencing a “perfect storm” of opportunity for estate and gift tax planning and savings. Please contact us if we can be of assistance.